Financial Constraints on Inventory Investment

Financial Constraints on Inventory Investment

Inventory has been studied by macro-economist for their role in the business cycles (Abramovitz 1950) and their relation with corporate profits (Mitchell 1951, Lucas 1977) and with the volatility of cash flows (Fazzari, Hubbard et al. 1988), both key leading indicators of the state of the economy (Carpenter, Fazzari et al. 1994); other evidence suggests their implications on the general level of the economy in case of financial shocks because of erroneous forecasts (Bernanke and Gertler 1989, Bernanke, Gertler et al. 1996) or their limited efficiency in collateralization (Berk 2014).

Clearly, the level of inventory is connected to the level of cash, but its relevance derives from the fact that inventory is a component of production. Indeed, the level of inventory is also determined by the overall strategy of operations, in this context variability and uncertainty affect inventory because it is used to reduce their impact on the processes of the firm (Chase 2016).

Firms internal policy influences also the decision to rely more on equity (Carpenter, Fazzari et al. 1994) or on debt (Whited 1992) for inventory investment. Once constrained firms are excluded, investment is more variable for firms with lower payout ratios and investment is less variable for more distressed firms. With the increasing evidence of the importance of the liquidity variables, the greatest difficulty has been constructing a suitable proxy for financial distress in order to classify firms as constrained: approaches included access to bond markets, dividend policy (Whited 1992) and financial health, the latter more focused on its impact in assessing government fiscal policy (Fazzari, Hubbard et al. 1988). Most of the studies have been questioned in the way the issue has been addressed on theoretical and technical grounds (Kaplan and Zingales 1997); a study of Japanese firms recognizes that even less constrained firms profiting from strong intra-Keiretsu bank relations broke such relation whenever it becomes possible (Hoshi, Kashyap et al. 1991, Hoshi, Kashyap et al. 1993): thus, mixed evidence characterizes the firm’s main bank relation, imputing distortions to agency costs and asymmetric information (Myers and Majluf 1984, Sharpe 1990, Rajan 1992, Kaplan and Zingales 1997). Recent approaches proxied financial distress with financial ratios and reconciled previous results: firms limited in internal funds require more external capital that increases in costs as it is more needed, thus constrained firms to invest more to generate more revenues (Cleary, Povel et al. 2007). Inventory investment seems to be financially constrained mostly before recessions when cash accumulation builds up (Kim and Choi 2001); similarly, trade credit increases when firms start to experience credit constraints (Egon 1997). However, some type of businesses, exporters and foreign-owned firms, enjoy better-operating conditions and less financial constraints (Mateut and Guariglia , Guariglia 1999).

A Stata study of the Relevance of Financial Constraints on Inventory Investment

Depending on the type of policy we may be able to infer the strategies of firms with respect to long- term interest rates, banks ratios credibility and the general level of the economy. If we assume that firms are pursuing a flexible short-term financial policy, relevant fact in our sample may include:

• large balances of cash and marketable securities

• large investments in inventory, generally long-term driven

• trade credit, resulting in a high level of accounts receivable

Such policy can be determined by other facts characterizing the current economic environment: long term credit is equally or less expensive than the average one decade old short-term credit, enabling established and healthy firms to borrow the need for the entire cycle avoiding the costs to re-contract short-term borrowings; financial products are perceived as too risky and banks ratios are not credible, suggesting firms to increase reliance on internal funds and accumulation of cash because of future increasing transaction costs and reduced marketability; low rates for long may suggest a slow recovery of the economy, requiring lower sale prices and more reduction in costs and liquidation of assets. Moreover, a policy of this type accomplishes with most backlogged lot size models suggesting demand Poisson distributed. Thus, inventory will be less constrained by financial factors and more affected by demand and production shocks.


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